The Tax Cuts and Jobs Act (TCJA) that became law a year ago has greatly rearranged the federal tax code, impacting such areas as pass-through businesses, deductions, foreign income, and exemptions.
The massive tax code change also left states scrambling to get their own tax codes to conform to the new law, and tax preparers and accountants having to study up to find out how the new tax rules would impact their customers and their business.
We spoke to Melissa Oaks, a managing editor for Thomson Reuters Checkpoint Catalyst®, about how states have reacted to TCJA and what tax practitioners need to know about the law and state conformity. Oaks presented a panel on this topic at the recent SYNERGY 2018 conference in November.
ANSWERS: In a general sense, how have states conformed to TCJA?
MELISSA OAKS: Most states base their income tax laws to some extent on federal Internal Revenue Code (IRC) provisions, though each state has its own approach and “decouples” from the IRC in some way.
There are two main styles of conformity to federal law – rolling and static. Rolling conformity means that the state automatically adopts changes to the IRC in the absence of legislative action. States with static conformity adopt the IRC as of a fixed date; in those states, legislative action is needed in order to adopt changes enacted after that fixed date.
As to TCJA, most states have passed the laws necessary to conform or decouple from various changes, but we’re still waiting on guidance across the board.
ANSWERS: I would guess that some states have conformed to the law to a much greater extent than others. Are there any standout states that have adapted to this tax law change better than others?
OAKS: It’s definitely a mixed bag so far. When it comes to tax policy, “better” is really in the eye of the beholder – what’s best for state revenues may not be what’s best for taxpayers; what’s best for businesses in one industry may be opposed by those in a different industry.
Broadly speaking, though, it’s helpful when states provide clear guidance in a timely fashion. With TCJA, some of the provisions affect the 2017 tax year, meaning state taxing agencies, legislators and practitioners have had to get up to speed quickly. There’s still a significant amount of uncertainty, and some of that won’t be resolved until we get clarifying federal guidance on TCJA. In the meantime, tax professionals are used to operating in gray areas and are figuring out how to best represent their clients in the absence of guidance.
ANSWERS: Are there any particular provisions of TCJA that have been more difficult for states to deal with effectively? How have they worked through that?
OAKS: We’ve seen some of the provisions in TCJA before, such as bonus depreciation and expensing, so states are used to making conformity decisions on those topics. But there are a few novel TCJA provisions for states to consider such as the one-time transition tax under IRC §965 and the new pass-through deduction under IRC §199A. By now, states have almost uniformly decoupled from the pass-through deduction by starting the calculation of state taxable income with federal gross or adjusted gross income; a few states have a similar state-level deduction.
With the transition tax, states have been issuing guidance on an ongoing basis, but the specificity varies from state to state, and there are looming constitutional questions.
ANSWERS: What about state and local tax (SALT) deductions? Are states finding a way to work around those?
OAKS: Under TCJA, the deduction for state and local taxes is capped at $10,000 per year, which has led some states to create complex work-arounds for their residents. The SALT deduction is primarily a federal tax issue, but these work-arounds raise new issues at the state level that state and local tax practitioners will need to examine closely.
The primary approach we’ve seen so far is the tactic pursued by New York – establishing charitable funds that taxpayers can contribute to, claim charitable deductions at the federal level (which are not subject to the $10,000 limit), and then get credits against their state and local tax liability.
The IRS proposed regulations in August that reduce the effectiveness of this strategy and actually ensnare some preexisting state tax credit programs related to school vouchers. That said, the IRS released further guidance in September, which leaves room for some planning opportunities.
States seem to be aware that these charitable contribution schemes are on shaky ground and are pursuing other work-arounds in tandem. New York passed a new payroll tax scheme while Connecticut created a new tax on pass-through entities, imposed at the entity level, with a corresponding credit against state income tax. These types of work-arounds were not addressed in the proposed regulations.
Even if your clients aren’t concerned with the SALT deduction, it’s important to be aware of these work-arounds because they can impact overall business taxation in a state and choice-of-entity decisions.
ANSWERS: There was also an issue of TCJA’s international provisions. How is that process going?
OAKS: The state tax impact of TCJA’s international provisions is still in flux. At SYNERGY, we discussed state tax treatment of “global intangible low-taxed income” (GILTI), “foreign derived intangible income” (FDII), and the transition tax.
Beyond inclusion or exclusion of the income in the tax base, multistate taxpayers also need to be aware of how these provisions affect apportionment.
As I mentioned before, there are also constitutional considerations – under the Foreign Commerce Clause, states are prohibited from discriminating against foreign commerce and, in 1992, the Supreme Court ruled that Iowa’s treatment of foreign dividends was unconstitutional.
ANSWERS: Do you think TCJA will have longer-term impacts on state revenue and state tax collection that may not yet be envisioned? How do you think states can best deal with that?
OAKS: TCJA is just one piece of the rapidly shifting state tax landscape. In June, the Supreme Court issued its opinion in South Dakota v. Wayfair, striking down the physical presence requirement for sales tax nexus. This opens up new revenue opportunities for states, and it will impact states’ overall revenue picture.
ANSWERS: You’ve mentioned about the new tax rules’ impact on tax professionals. What do you think are the best ways for them to stay on top of all these changes?
OAKS: Right now, it seems like we’re getting new guidance almost every day. Our daily newsletter, Checkpoint® State and Local Tax Update, is a great way to keep up with the latest developments.
The top priorities for each tax professional will vary, so focusing on what your existing clients need and what kinds of clients you want to represent in the future can help triage your learning plan. And don’t be afraid to ask questions – major overhauls like TCJA or the Tax Reform Act of 1986 are great equalizers – even the most experienced professionals are grappling with new concepts and processes.
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